Preparing for Funding Ep7: Seed Round – Recut

Office Hours is our podcast covering general issues related to small businesses and startups. Preparing For Funding is a series of Office Hours episodes hosted by VW Partners Kevin Vela and Rad Wood about getting your company’s legal house in order before taking on funding. We are recutting this series to reflect updates in law and venture trends in the last 5 years to better help you navigate through preparing for funding.

In the final episode of this series, we discuss seed rounds, including the difference between convertible notes, SAFEs, and equity rounds, and how seed rounds have changed over the last 5 years.

Time Stamps

  • 1:57 – Concern for Accelerators
  • 3:48 – Seed Rounds in 2018 v 2023
  • 10:24 – Convertible Securities: SAFEs & Convertible Notes
  • 15:03  – Why SAFEs Are Popular
  • 18:58 – Equity Rounds
  • 23:23 – Party Rounds, Lead Investors & Maturity Dates

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Click here to view terms used in this podcast

An Accelerator is a program whose intent is to “accelerate” the development of startups. Typically an accelerator will last one to three months and aims to provide support to startups through small amounts of seed capital, mentoring, training, and events for a finite period. It is common for an accelerator to receive some equity in the participating companies in exchange for the company’s participation in the program.

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Angel Financing

Angel Financing refers to a startup’s financing round whereby the investors are angel investors (see Angel Investor). This round typically comes after a Friends and Family round, but before a Series A round. Many Seed and AA rounds are composed of angel investors.

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Capital Stack

Capital Stack is the layers of financing in a company or project.

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Certificate of Incorporation (COI)

A Certificate of Incorporation is a state filing that creates a corporation once filed with the secretary of state. The filing informs the secretary of state about the name the company plans to operate under, whom the state can serve process on (the registered agent), where to mail important documents, and equity classification information.

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Control terms are terms that allow a VC to exert positive or veto control in a deal.

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Conversion Discount

A Conversion Discount is when the holder of a convertible note has a right to convert into a subsequent financing round or transaction at a “discount” to the price per share of that round.

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Convertible Note

A Convertible Note is short-term debt that converts into equity, typically in conjunction with a financing round. By using a convertible note, the investor would be loaning money to a startup, and instead of a return in the form of principal with interest, the investor would receive equity in the startup.

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Convertible Security

A Convertible Security is a security that may convert into another kind of security in a company. See Convertible Note.

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Dilution is the reduction in ownership percentage of a share of stock caused by the issuance of new stock.

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Distribution is a payment by a company to its shareholders (or members in the context of an LLC).

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Drag Along Rights

Drag Along Rights are the rights of majority investors who are selling their equity in the company to force minor investors to sell their equity interest as well.

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Early-Stage Financing

Early-Stage Financing refers to investments that happen early in a company’s lifecycle.

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Equity broadly refers to the ownership of a company, which can be represented by stock or other units of ownership. When an investor has ownership of a company, he or she has equity in the company.

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Equity Financing

Equity Financing is the direct investment by investors in exchange for ownership (equity).

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Friends and Family Round

A Friends and Family Round is the first round of funding for a company that consists of obtaining capital from founders’ friends and family.

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Information Rights

Information Rights are investors’ agreed upon rights to receive certain financial records and other information from the company. Some rights will provide timelines for the company to provide certain financial reports and statements to the investor. Most information rights also allow investors the opportunity to view these records in person and discuss the information with the company’s officers.

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Lead Investor

A Lead Investor is the investor who is leading a startup’s financing round. The investor leads by (1) writing the biggest check, (2) negotiating the terms, or (3) both. Oftentimes, a round can not really start until a lead investor is identified.

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Liquidation Event

A Liquidation Event is typically defined as a sale of substantially all of the assets of the company (not in a bankruptcy scenario). In investment agreements, liquidation events often trigger investors’ rights regarding distributions, conversions, or preferences.

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Liquidation Preference

Liquidation Preference specifies which investors get paid first and how much they get paid in the event of a liquidation event, such as the sale of a company. Liquidation preference helps protect investors by making sure they get their initial investment back before other parties. Preferred stockholders have preference over common stockholders.

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Major Investors

Major Investors are investors who own a large portion of a company’s shares and as such receive preferential rights. The amount of shares necessary to become a major investor varies among financial documents and companies.

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Most Favored Nations Clause

A Most Favored Nations Clause requires that the company gives the investor the best possible investment terms in the future. Note that this right usually expires after the next round. From a company perspective, try to avoid MFN clauses when possible.

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Party Round

A Party Round is a financing round with many participants, usually at small dollar amounts.

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Pre-Money Valuation

A Pre-Money Valuation is a company’s value before it has received any investment. The pre-money valuation determines how much equity an investor can purchase in the company for its investment.

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Preferred Stock

Preferred Stock is a type of equity security that is preferred or has preferences over the common stock, largely in terms of dividend payments and fixed payments upon a corporation’s liquidation.

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Price Cap

A Price Cap, also known as a Conversion Cap or Valuation Cap, is the greatest valuation used to convert a convertible note into equity in the company.

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Post-Money Valuation

A Post-Money Valuation is the valuation of a startup immediately after consummation of an investment round. This is calculated as pre-money valuation + cash invested = post-money valuation.

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Redemption Right

A Redemption Right is a right to make a company buy back, or “redeem” stock. A redemption right is typically requested by an investor in conjunction with a financing round.

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Representations and Warranties

Representations and Warranties are certifications of certain important facts by a party to an agreement to the other party to the agreement.

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Repurchase Option

A Repurchase Option is a company’s right to buy a shareholder’s stock upon some condition. Often, founders’ shares have a repurchase option if the founder leaves the company within a certain amount of time.

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Rights of Co-Sale with Founders

Rights of Co-Sale with Founders is a clause VC funds often want in investment agreements because it allows the fund to sell its shares at the same time as founders if the founders choose to sell their shares.

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Right of First Refusal (ROFR)

The Right of First Refusal (ROFR) is a contractual right for companies to purchase any shares that shareholders want to sell before the shares are offered to outside buyers.

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A Round is a financing event by which startups obtain investment, generally from family and friends, angel investors, or venture capitalists. The round is the entire set of investors in a particular offering or class of equity.

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SAFE is an acronym for “simple agreement for future equity,” which is an alternative to the issuance of convertible debt.

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Seed Capital

Seed Capital is very early-stage financing for a startup with a business venture or idea that has not yet been established. Capital is usually provided by angels and/or friends and family, though a small number of venture capitalists do provide seed capital.

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Seed Preferred

Seed Preferred is a round of financing before a series seed that is not quite as large as a true seed round, and therefore the investors do not receive the same rights as seed investors.

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Seed Stage

The Seed Stage is the initial stage in the life of a startup where a startup looks to establish its business venture or idea using seed capital. A Seed Stage round is sometimes referred to as a Series AA round.

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Series A Round

A Series A Round is generally the first significant capital funding event taken on by a startup, usually after that startup has raised some initial capital through a Friends and Family round, Seed round, or both. In a Series A round, the stock issued will typically be preferred stock designated as Series A stock. You may also hear this financing event referred to simply as an “A Round.”

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Side Letter

A Side Letter is an agreement between a company and a specific investor that alters the terms of the offering documents for that investor only, typically by providing the investor with additional rights or excluding the investor from certain obligations.

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Tag Along Rights

Tag Along Rights are contractual obligations protecting minority shareholders and are most common in venture capital deals. An illustration of how tag along rights work is when a majority shareholder sells his or her portion of the company and minority shareholders have a contractual right to join the transaction and sell their minority stakes in the company under the same terms as the majority shareholder.

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Term Sheet

A Term Sheet is a document that details the terms and conditions of the financing for an investment opportunity between an investor and a startup. It is usually non-binding. Note that in early stages of financing – Friends & Family and Seed – the company drafts the term sheet. But typically, once you get to a Series A round, the investors will draft the term sheet, or letter of intent (LOI).

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Unsecured Debt

Unsecured Debt is debt that is not backed by collateral in any of the assets of a company. Because the debt is not secured by any specific assets as collateral, any debt secured by specific collateral will take priority over the unsecured debt in the event of dissolution of the startup and sale of its assets.

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Venture-Backed Startup

Venture-Backed Startups are startups receiving venture capital funding. Most companies do not receive venture capital in early rounds of financing until they have proved the company is viable.

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Vesting is the period of time that securities (usually stock options) may be subject to forfeiture or repurchase based on meeting certain time or milestone criteria. Vesting co-founder equity helps to protect the company’s equity – so that a departing co-founder doesn’t depart with a lot of equity, but rather only the equity that has vested.

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Voting Rights

Voting Rights are the rights and/or obligations of a shareholder(s) to vote on certain corporate matters.

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Valuation is the process of determining a company’s worth. Valuations can be determined as multiplies of the company’s metrics or comparisons to other companies that recently valued at certain amounts.

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Other Podcasts in this Series
1 of 15 Preparing for Funding
Preparing for Funding Ep1: Incorporation
2 of 15 Preparing for Funding
Preparing for Funding Ep2: Founders Agreements
3 of 15 Office Hours
Preparing for Funding Ep3: Friends & Family Funding
4 of 15 Preparing for Funding
Preparing for Funding Ep4: Pitch Decks
5 of 15 Office Hours
Preparing for Funding Ep5: Initial Sophisticated Investors
6 of 15 Office Hours
Preparing for Funding Ep6: Accelerators / Incubators
7 of 15 Office Hours
Preparing for Funding Ep7: Seed Round
8 of 15 Office Hours
Preparing for Funding Overview
9 of 15 Office Hours
Preparing for Funding Ep1: Incorporation – Recut
10 of 15 Office Hours
Preparing for Funding Ep2: Founders’ Agreements – Recut